The Basle Committee on Banking Supervision¹ (Basle Committee) and the Technical Committee of the International Organisation of Securities Commissions² (IOSCO Technical Committee) have undertaken their third survey³ on the public disclosure of trading (on-balance-sheet instruments and off-balance-sheet derivatives) and non-trading derivatives activities⁴ of banks and securities firms. This survey represents a continued effort by the two Committees to encourage banks and securities firms to provide market participants with sufficient information to understand the risks inherent in their trading and derivatives activities.

The Committees' efforts are consistent with, and reinforced by, the report of the G-7 Finance Ministers on promoting financial stability submitted to the G-7 Heads of State in conjunction with the Denver summit in 1997, which states that public disclosure can enhance market discipline by improving the information available to market participants. In their report, the G-7 Finance Ministers encourage supervisors to further promote disclosure. The role that appropriate disclosure can play is also stressed in the Basle Committee's Core Principles for Effective Banking Supervision, which note that banks should disclose information that is timely and sufficient for market participants to assess the risks inherent in any individual banking institution⁵.

The results of this third survey show that the disclosure practices of 79 internationally active banks and securities firms improved in 1996 annual reports. This is particularly true with respect to the disclosure of value-at-risk data and the assumptions underlying value-at-risk models. Also, institutions expanded their discussion of operating and legal risks, and provided more information about the valuation techniques for trading and derivatives activities and the accounting treatment for derivatives credit losses.

Notwithstanding the aforementioned improvements, the types of disclosure provided by different banks and securities firms vary, and some firms continue to disclose little about their trading and derivatives activities. Therefore, institutions are strongly encouraged to consider the recommendations for quantitative and qualitative disclosures issued by the Basle Committee and the IOSCO Technical Committee; as well, firms should consider disclosure initiatives by other national and international bodies, and the types of disclosures provided by their peers at the international level.

(2) Objective

As with the previous reports, this document intends to provide a picture of the advances in disclosure practices of a sample of internationally active banks and securities firms for trading and derivatives activities and to encourage internationally active banks and securities firms to further enhance their disclosures. The Basle Committee and the IOSCO Technical Committee believe that meaningful public disclosure plays an important role in reinforcing the efforts of supervisors to encourage sound risk management practices and foster financial market stability. Improved disclosure should also benefit banks and securities firms themselves by enhancing their ability to evaluate and manage their exposures to other counterparties and reducing the likelihood that they become susceptible to market rumours and misunderstandings during periods of financial stress.

(3) Recommendations of the November 1995 report

In November 1995, the Basle Committee and the IOSCO Technical Committee issued a report on the public disclosure of trading and derivatives activities of banks and securities firms. It contained a series of recommendations for further improvement of qualitative and quantitative disclosure about how trading and derivatives activities contribute to the overall risk profile and profitability of large banks and securities firms with significant involvement in trading and derivatives activities, combined with information on their risk management practices and actual performance. These recommendations drew on the concepts developed in the Discussion Paper on Public Disclosure of Market and Credit Risks by Financial Intermediaries ("the Fisher Report"), released by the Euro-currency Standing Committee of the G-10 central banks in September 1994 and on the Framework for Supervisory Information About the Derivatives Activities of Banks and Securities Firms ("the Supervisory Information Framework"), released jointly by the Basle Committee and the IOSCO Technical Committee in May 1995. The recommendations are reproduced in the annex to this paper and follow two main themes.

First, as recommended in the Fisher Report, institutions should disclose quantitative information, produced by internal risk measurement and management systems, on their risk exposures and their actual performance in managing these exposures. Drawing on internal systems would help to ensure that disclosure practices continue to improve with innovations in risk measurement and management techniques.

Second, institutions should provide financial statement users with a clear picture of their trading activities and their overall involvement in the derivatives market, as well as the impact of these activities on earnings. For guidance about meaningful types of information and fundamental disclosures about derivatives activities, institutions are encouraged to look to the catalogue and common minimum framework presented in the Joint Basle Committee / IOSCO Supervisory Information Framework paper, issued in May 1995. Disclosure of information that is consistent with the common minimum framework could improve the consistency and comparability of basic annual report disclosures about overall market activity in derivatives, and their credit risk.

Qualitative disclosures should offer an overview of the institution's overall business objectives, its risk-taking philosophy, how trading and derivatives activities fit into these overall objectives, as well as the principal internal control procedures that are in place for managing these activities. Also, qualitative disclosures should provide depth to the quantitative disclosures of these activities. Recommended qualitative disclosures include descriptions of major risks arising from trading and derivatives activities and the methods used to manage these risks, information about overall objectives and strategies for trading activities, and discussion of significant valuation and accounting policies.

Quantitative disclosures should include comprehensive summary information about an institution's involvement in trading and derivatives activity, its exposure to credit risk and market risk and its performance in managing these risks. Institutions should also disclose how trading and derivatives activities affect reported earnings. Recommended quantitative disclosures include summary information on the composition of trading portfolios, disclosures based on internal methodologies, value-at-risk data and major assumptions underlying value-at-risk estimates, and information on how trading activities affect earnings.

(4) National and international developments affecting disclosure

In addition to the recommendations issued jointly by the Basle Committee and the IOSCO Technical Committee on trading and derivatives disclosure in November 1995 and reinforced in this report, several other national and international bodies have recently issued proposals or rules that have affected 1996 disclosures, and other such proposals are under development. Many of these initiatives are likely to influence future disclosures about trading and derivatives information. These initiatives include:

• International Accounting Standard IAS 32 "Financial Instruments: Disclosure and Presentation". IAS 32 was issued by the International Accounting Standards Committee (IASC) in June 1995, and includes requirements for disclosure of terms, conditions and accounting policies for financial instruments, interest rate risk and credit risk data, and the fair value of on- and off-balance-sheet financial instruments.

• The IASC Discussion Paper "Accounting for Financial Assets and Financial Liabilities". This discussion paper, published in March 1997, advocates using fair values instead of historical costs to account for financial assets and financial liabilities. The discussion paper is not a formal proposal, but it considers important arguments about the usefulness of financial information. It also recommends expanded disclosure about financial risks, and the objectives and strategies for managing those risks.

• The Japanese Ministry of Finance's new regulations about market value accounting for trading activities. As from 1 April 1997, Japanese banks and securities firms may adopt mark-to-market accounting for their trading activities (including derivatives), provided they meet certain approval standards on internal control, valuation and accounting procedures set by the Ministry. This change improves the information available to the public about banks' and securities firms' periodic performance in their trading and derivatives activities⁶.

  Furthermore, in July 1996, Japanese ministerial ordinances and circulars (e.g. Regulation concerning Terminology, Forms and Method of Preparation of Financial Statements, etc.) were revised to enhance derivatives disclosure of all firms. The revisions are effective from the period that ended in March 1997 and require firms to disclose qualitative information as well as notional amount information for all derivatives, including over-the-counter instruments. The revisions also include a recommendation for the disclosure of quantitative information on market risk and credit risk. Moreover, as from the period ending in March 1998, disclosure of market value information for over-the-counter instruments will be required.

• The UK Accounting Standards Board (ASB) Financial Reporting Exposure Draft 13 (FRED 13), with Supplement. The ASB issued FRED 13 in April 1997, and its Supplement, which sets out modifications for banks and similar institutions, in September 1997. Some of the key proposals are that banks disclose their objectives, policies and strategies in holding or issuing financial instruments, specified information on interest rate, currency and liquidity risks as well as value-at-risk, sensitivity analysis or other market price measure figures with respect to the trading book. In addition, it is proposed that fair value information be given for all financial assets and liabilities held in the trading book and for some financial assets and liabilities held in the non-trading book, namely all derivatives and other financial assets and liabilities for which a liquid and active market exists.
• The US Securities and Exchange Commission (SEC) "Market Risk" disclosure rule. This rule was proposed in 1995 and was finalised by the SEC in January 1997. The rule affects the largest institutions in the US and all banks and savings associations beginning with statements filed after 30 June 1997. In addition to requiring specific quantitative and qualitative disclosures about market risk, it requires specific disclosures about an institution's accounting policies relating to derivatives. Although this rule was not in effect for the 1996 reports, it may have had some influence on market risk disclosures.

• The Fédération des Experts Comptables Européens (FEE) report "Accounting Treatment of Financial Instruments - A European Perspective". The report was published in December 1996 and recommends disclosure of qualitative information about the use of financial instruments and the management of related risks, and quantitative information about the exposure to credit and market risks in a form consistent with the bank's management of those risks.
• The amended Basle Capital Accord for market risk capital rules and the EU capital adequacy directives. The disclosure of information about the regulatory capital charges for market risks and their calculation became common in many countries in 1996. The amended Basle Capital Accord requires that market risk capital rules be implemented for internationally active banks in the G-10 countries as of January 1998. According to European Union law, market risk capital rules were to be effective by year-end 1995 for banks and securities firms in EU member states.

(5) Overall survey results and recommendations

The amount, detail and clarity of trading and derivatives-related disclosures in annual reports of banks and securities firms improved substantially over the 1993-1996 period. Overall, the banks and securities firms included in the survey significantly enhanced their disclosure of qualitative and quantitative information about credit and market risks associated with their trading and derivatives activities.

In comparison with 1995, progress in disclosure practices continued in 1996 annual reports, although the improvement was less pronounced than in previous years. The most noticeable improvement in 1996 was the sustained expansion of disclosure of value-at-risk data. There was a large increase in the number of institutions that provided quantitative disclosures drawn from their internal value-at-risk methodologies and of the major assumptions underlying their value-at-risk models. Management discussion of operating and legal risks also expanded. In addition, institutions provided more information about the valuation techniques for their trading and derivatives activities and the accounting treatment for derivatives credit losses. Furthermore, the number of institutions that distinguished between over-the-counter and exchange traded instruments in their disclosure of notional amounts increased. In other areas, the progress in disclosure practices from previous years was generally sustained. The Committees strongly encourage banks and securities firms to continue their efforts to develop more meaningful disclosures for their trading and derivatives activities.

Despite these improvements, there remain significant disparities, both within and across countries, as regards the type and usefulness of the information disclosed. For instance, only a few institutions in the sample related value-at-risk data to actual changes in portfolio value, as discussed in the Fisher Report, and less than half of the institutions provided information on trading income by risk exposure or line of business. Moreover, some institutions continue to disclose little, generally, about key aspects of their trading and derivatives activities. These institutions are strongly encouraged to consider the quantitative and qualitative recommendations contained in the November 1995 report, summarised in section I (3) and reproduced in the Annex. In addition, all banks and securities firms should consider disclosure initiatives by other national and international bodies, and the types of disclosures provided by their peers at the international level, as outlined in Tables 2-6 of this year's disclosure survey.

While the focus of this report is on trading and derivatives activities, the importance of enhancing disclosure of information in other areas should also be considered. The Basle Committee and the IOSCO Technical Committee will continue to study the issue of disclosure and monitor improvements in banks' and securities firms' disclosure practices for different activities and risk exposures over the coming years. Both Committees expect that firms will continue to enhance - and where necessary expand - their disclosures in line with the growth in the level and complexity of their business activities.

Footnotes:

1 The Basle Committee on Banking Supervision is a committee of banking supervisory authorities which was established by the central bank Governors of the Group of Ten countries in 1975. It consists of senior representatives of bank supervisory authorities and central banks from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States. It usually meets at the Bank for International Settlements in Basle, where its permanent Secretariat is located.

2 The Technical Committee of IOSCO is a committee of the supervisory authorities for securities firms in major industrialised countries. It consists of senior representatives of the securities regulators from Australia, Canada, France, Germany, Hong Kong, Italy, Japan, Mexico, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom, and the United States.

3 The earlier surveys were published in November 1995 and November 1996, respectively.

4 From now on referred to as "trading and derivatives" activities.

5 The Core Principles for Effective Banking Supervision (the "Basle Core Principles") was issued by the Basle Committee in September 1997.

6 It should be noted that mark-to-market or fair value accounting for trading activities already is accepted practice for all or part of the trading book also in many other countries.